Big banks craft 'living wills' in case they fail

June 27, 2012|Reuters

* Plans must show how to close bank safely

* Public goal: Stop too-big-to-fail bailouts

* Possible result: Smaller banks

By David Henry and Dave Clarke

NEW YORK/WASHINGTON, June 27 (Reuters) - Five of the biggestbanks in the United States are putting finishing touches onplans for going out of business as part of government-mandatedcontingency planning that could push them to untangle theircomplex operations.

The plans, known as living wills, are due to regulators nolater than July 1 under provisions of the Dodd-Frank financialreform law designed to end too-big-to-fail bailouts by thegovernment. The living wills cou ld be as long as 4,000 pages.

Since the law allows regulators to go so far as to order abank to divest subsidiaries if it cannot plan an orderlyresolution in bankruptcy, the deadline is pushing even healthyinstitutions to start a multi-year process to untangle theircomplex global operations, according to industry consultants.

"The resolution process is now going to be part of thecost-benefit analysis on where banks will do business," said DanRyan, leader of the financial services regulatory practice atPricewaterhouseCoopers in New York. "The complexity of theorganizations will shrink."

JPMorgan Chase & Co, Bank of America Corp,Citigroup Inc, Goldman Sachs & Co and MorganStanley ar e among th ose submitting the first liquidationscenarios to regulators at the Federal Reserve and the FederalDeposit Insurance Corp, acco rding to people familiar with thematter.

The five firms, which declined to discuss their plans forthis story, have some of the biggest balance sheets, tradingdesks and derivatives portfolios of financial institutions inthe United States.

Great Britain and other major countries are imposing similarrequirements for "resolution" plans on their big banks, too.

The liquidation plans are coming amid renewed questionsabout the safety of big banks following JPMorgan's stunningannouncement last month that a trading debacle has cost it morethan $2 billion - a sum far too small to endanger the bank, butshocking enough to bring back memories of the financial crisis.

A NOD TO GLASS-STEAGALL

If the extensive planning and review process works asproponents hope, big banks will become less hazardous to thepublic and regulators will be more confident that they can letwounded institutions die without wrecking the economy.

In congressional hearings earlier this month, JPMorgan CEOJamie Dimon said that the bank's contingency plan for going outof business would let it fail without cost to taxpayers. Livingwills reduce the systemic risk of a big bank failing, Dimonsaid.

Bair said regulators may determine that for a liquidationplan to w ork, a b ank must separate traditional banking andinsured deposits into subsidiaries set apart from volatilesecurities trading and securities underwriting.

The rules push banks to untangle their complex structures,which can include thousands of legal entities, a nd which, inBair's opinion, have effectively blocked proposals for breakingup the corporations.

Whether the Fed and the FDIC would actually force any banksto sell businesses or cordon off insured deposits remains to beseen, cautioned Richard Herring, a banking professor at theUniversity of Pennsylvania.

"We don't know if they will have the guts to do it, but thetools are there," said Herring, a leading proponent of livingwills for more than a decade, who was appointed to an FDICadvisory panel on the pla ns.

Herring worries , too, that the plans will be so long andcomplex that they will overwhelm the staff at the agencies.

Still, that the plans are being written at all is progress,Herring said.

PLAN FOR TWO WAYS TO DIE

Under the Dodd-Frank Act, banks and regulators must imagineliquidations in two different ways. The first is throughbankruptcy courts with banks negotiating with their creditors.This is the going-out-of-business method planned in the livingwills due July 1. The living wills must include how subsidiariesin foreign jurisdictions will be liquidated.

The second way is through a new kind of liquidation processin which the FDIC takes control of putting a financial giantdown. Th is method has more flexibility than is allowed inbankruptcy courts, but still uses critical information collectedin the banks' living wills, such as where exactly to findcollateral.

The new rules stagger deadlines for the banks to file plans,depending on their size and complexity. Nine banks will filefirst, including five based in the United States and four ownedabroad. Regulators have declined to name the nine banks includedin the first round.